Denmark has said the winner in the competition to replace its F-16 fighter jets will be based on the contractor's ability to create jobs and generate subcontracts for Danish firms. (Getty Images)

HELSINKI — The Danish government, in a pre-emptive strike aimed at protecting the country’s defense industry against impending European Union (EU) reforms that would phase out the use of offsets, is drafting new legislation that could appease the EU and enable Denmark to retain much of its offset structure for large-scale international military contracts.

The legislative action represents a marked reversal in Denmark’s policy, which traditionally demands 100 percent offsets on major military equipment purchases.

As recently as August, Defense Minister Nicolai Wammen told US and European bidders for the US $5 billion F-16 fighter replacement program that the selection decision will be based on the number of “jobs created and subcontracts generated” for Danish firms.

The Defense Offset Bill, which is being drafted by the Ministry of Business And Growth, will reach the Danish Parliament in February 2014. Denmark wants to negotiate special-case terms with the EU that allow it to retain offsets as a tool to grow the country’s modest-sized defense sector.

The bill is based on policy recommendations advanced by the Danish Business Authority, which advises the government on EU and international competition matters. Final amendments to the bill will take place after European heads of state convene for a European Council meeting in Brussels on Dec. 19-20.

This meeting will shape the European Commission’s (EC’s) Common Security and Defense Policy, with discussion centered on the implementation of directives that inject greater competitiveness into European defense contracts. Central to this plan is a proposal to phase out the use of offsets as the basis for defense contracts within the EU.

The Danish government will need time to formulate amendments that satisfy EU requirements on military offsets. The best-case scenario, said Henrik Sass Larsen, Denmark’s business and growth minister, is that Denmark will be able to create a new legal structure around offsets that conforms to EU competition rules, but does not prevent Denmark from continuing to use offsets, Larsen said.

“It is difficult to predict exactly what the outcome will be. Our objective is that we continue to build a strong defense industry in Denmark. It should be noted that some 75 percent of the industry’s output is exported,” Larsen said in an interview. “Offset is critical to growth within the defense industry area. Therefore, we want to continue to have the ability to use offset for military contracts.”

The EC has repeatedly criticized Denmark for failing to abolish industrial offsets from its legal framework and military procurement practices.

The objectives of the Defense Offset Bill largely reflect industry thinking on the use of offsets as a viable mechanism to channel potentially lucrative sub-contract business from significant defense contracts, won by foreign suppliers, to local defense firms.

Industry wants the Danish government to negotiate a solution under which the EU would agree to allow Denmark to operate one set of rules for industrial cooperation agreements to suppliers from the EU together with a separate system for suppliers from non-EU countries.

The industry view, said Tomas Ilsøe Andersen, a partner at the Copenhagen-based law firm Kammeradvokaten Poul Schmith, is that a dual-track solution is feasible and would compel Denmark to conform to the EU’s planned internal restrictions on offset while continuing to use offset for large-scale contracts with non-EU suppliers.

“Certain large acquisitions, which may span 30 to 40 years in terms of the operation of military equipment, have significant security implications for a small country like Denmark. This is very much about maintaining a national industry which can ensure retention of Danish know-how and technical support skills. This is needed in a world where the balance of power, and alliances, can change quickly,” Andersen said.

Denmark, he added, can argue its case based on sovereignty and national security policies that are reliant on a defense strategy that not only includes industrial offsets, but which uses offsets to protect the nation’s ability to retain skills and military assets integral to national defense.

The Danish government will present its legal case for a restructured offset policy when it meets with EU heads of state in December.

The EC should treat smaller EU nations, such as Denmark, as special cases when it comes to industrial military offset practices, said Frank Bill, the director of Denmark’s Defense and Security Industries Association.

“In real world terms we cannot really talk about a European defense market. Between 80 and 90 percent, in value, of all procurement contracts within the EU are placed nationally,” Bill said in an interview. “The acquisitions of small nations are irrelevant to the European market as a whole in this context. The government must insist that Denmark be allowed to determine its own defense and security policies.”

Previous offset deals, such as Denmark’s acquisition of F-16s in the 1980s, had a positive impact on growing Denmark’s defense industry, Bill said. Adding an offset dimension to the re-started fighter replacement program is essential to further growing this base, he added.

Denmark will need to negotiate an offset deal with the EU on the basis of “realistic expectations,” said Lars Barfoed, the Danish Conservative party’s chairman.

“The European Commission is determined to build on its directives on defense procurement and transfers and phase-out offsets. The general objective here is to strengthen the efficiency and competitiveness of the defense and security sectors in Europe,” Barfoed told Defense News. “In the area of procurement, the EC is establishing a market monitoring mechanism. A lot is happening, and will happen. Denmark must be smart and persuasive in negotiating the best deal within these confines.”

Denmark will be lucky to extract any concessions covering the retention of offset rights from the EU, said Martin Trybus, professor of European Law and Policy at the University of Birmingham.

“I can’t imagine that the EU Commission will accept counter-trade as part of the Danish acquisition of new aircraft,” Trybus said. “I do not see what arguments Denmark can field that will justify counter-trade under the new rules.”

Danish negotiations with the EU will likely focus on the retention of offsets for non-EU third market deals, said Pietr Wauters, a Brussels-based political analyst.

“It’s not that the Danes do not accept that offset is inefficient and adds to the final cost of procurement; they do. The issue here is protecting a native defense sector that continues to benefit from offset-based orders,” Wauters said. “It can expect some degree of EU support to retain offset for third markets as any concessions here will only have a marginal impact on Europe’s defense industrial base. The EC is well aware that offset is a common feature of defense equipment deals in Asia, the Middle East, Africa and South America.”